Economic Outlook: Happy New Year?
- Will we have much to celebrate at the end of 2015? As we look back now at 2014, it was an interesting year for the global economy.
- The U.S. economy surprised most observers by emerging from the 2.0% growth range and solidly pushing toward the 3.0% range.
- Despite the fears of inflation breaking out, the core inflation range remained comfortably in the 1.0% to 2.0% range, although closer to 2.0% as the year ended.
- The Fed has transitioned from the market’s best friend to perhaps being somewhat more neutral as the year closes out.
- The U.S Federal Budget deficit continued to shrink in the expanding economy and is now approaching 2.5% of GDP. The total deficit in 2015 might drop to $400 billion, considerably lower than the worst position in 2009 at $1.4 trillion.
- There was great divergence as international economies significantly lagged U.S. performance and are struggling to get re-started in the direction of growth. The Euro-zone in particular is bouncing along the bottom.
- As our Investment Committee looks forward and discusses the U.S. outlook for 2015, we believe the outlook for recession in the U.S. is extremely low (growth could easily exceed 3.0%) and that the environment will continue therefore, to be attractive for stocks.
- Inflation is low, and there is no real evidence to suggest a significant pick-up in inflation in the near term. While interest rates could begin to firm, this does not appear to be a trend that will unfold quickly.
- ISM’s Manufacturing Index is holding steady in expansion territory at 55.5 on the most recent reading. No slow-down in the U.S. is in evidence.
- Low energy prices represent a challenge for the energy industry, but they are a net gain for the U.S. economy and most of the world and put more real income in the pockets of American households. The Conference Board’s Consumer Confidence Survey just released is at 92.6, the second highest reading of the recovery. Cheap gasoline prices at the pump have an impact on this.
Equities Outlook: Hand wringing aside, it was a pretty good year.
- The final numbers are in for 2014. Despite all the hand-wringing over various issues that led to volatility during the year, it was a solid year for U.S. equities.
- The S&P 500 Index posted a total return of 13.7% for the year. Only a single sector with the index (Energy) was negative for the year. The other major large capitalization equity index which we monitor – the Russell 1000 – was up a similar amount.
- Smaller U.S. stocks posted positive results, but were not up as much. The Russell 2000 Index of smaller companies ended the year with a total return of 4.9%, showing a bit of reversion to the mean after very strong relative results compared to large cap stocks for several years preceding 2014.
- International equities, as measured by the MSCI-EAFE Index were the only significant area in the red for 2014, showing a 4.9% decline on a total return basis.
- For the reasons noted above, we believe 2015 is likely to represent a year where U.S. corporate earnings rise and the dollar remains relatively strong.
- 2015’s economic outlook continues to suggest low interest rates, an environment good for stocks. It is a stretch to foresee conditions that would represent some sort of spike upwards in interest rates. The Federal Reserve may indeed commence raising short-term rates, but we may well see the yield curve simply flatten. Only when it becomes inverted or begins rising on the long end will it become more worrisome for economic growth, and therefore stock prices.
- The drop in oil prices could certainly persist in the short term, making it difficult for the energy sector. However, our view is that we are not likely far from the place where a recovery in the energy pricing environment begins. It may be awhile before we get back to $90-$100, but we do not look for extended declines from here.
- Lower oil prices have the effect of changing the base-line equation for international equity investing. If low prices persist, certain economies are major beneficiaries: Japan, Phillipines, Spain, and Italy. Lower oil prices mean a rise in real incomes for these countries. On the other hand, those same prices are bad news for certain producers, particularly less efficient producing countries: Russia and Venezuela. They are penalized. The gap between winners and losers widens with lower prices.
Fixed Income Markets: Does ECB Stimulus Reach the U.S.?
- Lower oil prices essentially guarantee (for the reasons noted above) that there will be no near-term inflation in the Euro-zone. This means the door is wide open for very liberal quantitative easing by the ECB. This does not mean that Europe will get growth rivaling the U.S., but conditions will improve and its relative position will become more favorable. With European equity valuations at very attractive levels, this sets the stage for improved relative returns.
- The low interest rates in foreign market provide a form of competition that tends to put some lid on interest rates in the U.S.
- The interest rate on the ten-year U.S. Treasury Note ended last week at 2.11% on Friday. This is unchanged from where it closed the last Friday we posted comments in mid-December (2.11%).
The Week Ahead
- ISM Services Report (ISM)
- U.S., Factory Orders
- ADP Employment Report (ADP)
- U.S., FOMC Minutes Released
- U.S., Employment Report (BLS)